How cashflow modelling can act as an early warning system for financial shocks

Financial shocks can have a devastating effect on your short- and long-term finances. While you can’t remove the unexpected from your life, it is possible to be prepared, and a cashflow model could help you identify how.

A cashflow model could help you visualise changes to your wealth

A cashflow model is a powerful tool that financial planners can use to show how your wealth might change over the long term in various scenarios.

To start, you’ll input essential information, such as the value of your assets, your income, and how you use your money each month. Then you can make certain assumptions, such as the rate of inflation, potential investment returns, or your expected retirement date, to see how your wealth might change over the years.

It’s important to note that the results of a cashflow model cannot be guaranteed, as they rely on the data added and assumptions that might prove inaccurate. However, they can provide a valuable way to visualise your long-term wealth and assess the effect of your decisions.

You could use a cashflow model to stress-test your finances

One of the reasons cashflow modelling is useful is that once it’s set up, you can adjust the assumptions to model different scenarios.

If you’re concerned about financial shocks, you can effectively use it to stress-test your finances and as an early warning system. Identifying potential gaps sooner could mean you’re in a position to close them.

As a result, cashflow modelling could help you manage worrisome “what if?” questions.

Imagine you’re the main income earner for your household and you’re worried that your family wouldn’t be able to cope if you were unable to work.

You can use a cashflow model to stress-test your finances and show how long they would last without an income. For example, you might assess how quickly your emergency fund would be depleted.

Armed with this information, you might be able to address potential weak spots in your finances.

In this case, if you found your emergency fund would only cover essential bills for two months, you might start by saving more to build it up. In addition, you may consider taking out appropriate financial protection that would provide an income if you couldn’t work due to an accident or illness, to further improve your financial resilience.

There are many other types of financial shocks where a cashflow model could be useful too, from a period of downturn leading to falling investment values to a large, unexpected household bill, such as needing to replace your home’s roof.

A cashflow model can help you assess the effects of a shock after it’s happened

If you experience a financial shock that you hadn’t previously considered, a cashflow model could still be useful.

It can be difficult to assess the long-term effect of a shock. By adding it to your cashflow model, you may be able to understand whether your goals remain on track and whether any adjustments are necessary.

Imagine you’d previously planned to retire at 65 and calculated that you’d have enough to take a sustainable income that would afford you the lifestyle you’ve been looking forward to.

However, ill health means you now need to bring forward your retirement by three years. This might not be something you’ve considered before. You’re now unsure whether you’ll be financially secure later in life or if you need to reduce your outgoings in retirement.

Updating your cashflow model following this life event could enable you to assess the long-term effects. It could give you the confidence to make decisions, even when life is unpredictable.

We could help you improve your financial resilience

If you’d like to understand if you’re vulnerable to financial shocks and how you might improve your resilience to them, please get in touch.

Please note: This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

Note that financial protection plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.

Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.

The Financial Conduct Authority does not regulate cashflow modelling.

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